Insolvent Trading Director Liability — understand your exposure and protect your assets

Section 588G of the Corporations Act 2001 provides that a director contravenes this section if: the company incurs a debt at a time when the company is insolvent, or becomes insolvent by incurring the debt; and at that time there are reasonable grounds for suspecting that the company is insolvent or would become insolvent. Insolvency is generally assessed on a cash flow basis — whether the company can pay its debts as and when they fall due. A director found to have contravened section 588G can be ordered to personally compensate creditors for losses arising from the relevant debts.

Director liability arises at the moment each relevant debt is incurred — not at the point of liquidation. The liquidator must identify each individual debt incurred while the company was insolvent (or that caused insolvency), establish that there were reasonable grounds to suspect insolvency at that time, and show that the director was aware of those grounds or ought to have been aware. The amount of any compensation order is generally limited to the loss suffered by creditors on those specific debts, not the entire company deficit.

Section 588GA of the Corporations Act 2001 provides a safe harbour from insolvent trading liability for directors who are developing a restructuring plan likely to produce a better outcome for the company and its creditors than immediate administration or liquidation. To access safe harbour the director must: start developing the course of action before the debt is incurred; be taking steps that are reasonably likely to lead to a better outcome; ensure employee entitlements (wages and super) are paid when due; and ensure the company's tax reporting obligations are up to date. Meticulous documentation of the restructuring process is essential to support a safe harbour claim.

Under section 588M of the Corporations Act 2001, a liquidator may bring proceedings in a court to recover compensation from a director who contravened section 588G. The claim is for the amount of loss or damage suffered by the creditor whose debt was incurred while the company was insolvent. Liquidators typically investigate trading patterns, financial statements, and bank records to identify the date of insolvency and quantify the relevant debts. ASIC may also intervene in proceedings or fund litigation in appropriate cases.

Section 588H of the Corporations Act 2001 provides several defences: (1) the director had reasonable grounds to expect the company was solvent; (2) the director relied on information from a competent and reliable person responsible for financial management; (3) the director was not taking part in management due to illness or other good reason; or (4) the director took all reasonable steps to prevent the company from incurring the debt. These defences are fact-specific and require evidence — they cannot simply be asserted without documentation to support them.

Section 588M claims must generally be brought within six years from the date of the relevant contravention (that is, when the debt was incurred). However, the liquidation process can extend the practical timeframe, as the liquidator may not identify and quantify the insolvent trading claims until some time after appointment. Directors should retain financial records and communications for at least six years from the relevant period to support any future defence. Early legal advice is essential even if you have not yet heard from a liquidator.