What is insolvent trading, who decides and how?

Yes, directors can be made liable for company debts via insolvent trading especially after ATO tax debt gets out of hand or a judgement order hits. One of the lines a liquidator will use to frighten you in to signing up to appoint him so he can get work and fees (without proper preparation to ensure you and your business wealth are protected) is that you risk insolvent trading and personal liability if you continue to operate the business. Not necessarily. Yes directors have to be careful particularly with ATO tax debt and directors penalty notices and personal guarantees. But with proper advice insolvent trading is not a huge risk. The urgent thing is to identify your options and prepare carefully.

As a director you can be sued for the losses incurred by a creditor if you trade while insolvent. Right? Well maybe.

‘Maybe’ number 1

There are two kinds of ‘trading’. One is where you buy things (or services) for cash or some other form of immediate consideration for the benefit of the company. This is perfectly OK even if your company insolvent. The other is where you buy on credit. This is where you could get sued.

‘Maybe’ number 2

You have to have had reasonable grounds for suspecting the company could not pay its debts as and when they fell due AND the company has to become insolvent AND no one else pays the debt. For example when after ATO tax debt gets out of hand or a judgement order is made against the company.

‘Maybe’ number 3

A liquidator has to prove the company was insolvent at the time of the alleged insolvent trading. You might believe that you could have paid the tax debt claimed by the ATO or judgement debt if your reasonable expectations had been. Plus, that a reasonably diligent director should have known or suspected the company was insolvent (ignorance or unbridled optimism is no excuse nor is the hope that the big deal will come off but it gives you something to argue). And proving all this, could cost the liquidator up to $60,000. Creditors could be very reluctant to allow the liquidator to spend money that might otherwise go to them on legal fees. They would be even less likely to pay for such legal fees if there is no money left in the company to do so.

A Warning

While the task of proving ‘insolvent trading’ is difficult, the easiest way is to establish that the company had no accounting records. The usual way to prove this is by admission (they could be genuinely lost or mistakenly destroyed). So it is really important to be careful making admissions to a liquidator. Get advice before you do so.

So it is fine to continue to buy things for cash even if you do know the company is or may be insolvent.

Alarm Bells

A recent survey of over 100 accountants revealed that, on average, they estimated the proportion of director-clients who did not understand the Declaration of Solvency they signed with the accounts every year at a whopping 80 per cent – that’s right, 80 out of every 100 – some said 100%

The law requires directors to be ‘reasonably’ informed about their company’s financial status. To find out more about what the indicators of insolvency click here.

The key to surviving and avoiding a crisis is to understand the early warning signs.

The directors of most of liquidated businesses believed it couldn’t happen to them.

In many cases, the insolvency of the company under the Corporations Act gives rise to the bankruptcy proceedings for the directors or owners, if negligence in their duties to creditors is proven or by virtue of personal commitments on guarantees given to the company or lenders and creditors to the company.

If you are concerned about whether or not your company is insolvent, go to How do I know if my company is insolvent?