Day 129 Insolvent trading

Insolvent trading

The company has been treated as the best investment vehicle due to the characteristic of a separate entity. Hence the corporative veil would effectively protect directors from becoming personally liable on the company’s debt. However, there are several exemptions that may pierce the corporative veil and make the director compensate the creditors’ loss. The most common approach is the director’s duty to prevent insolvent trading.

According to S.588G Corporations Act(2001)(Cth), the director is required to prevent the company turn out to be insolvent even there is only a suspicion. In order to determine whether the director has breached this statutory provision or not, there are three factors to consider. At first, we need to define the term ‘insolvency’. Section 95A suggested that a company became insolvent when the debt cannot be repaid on due date. Therefore, if a person was the director when the debt occurs, that person will breach the duty. In addition, we should understand the reasonable ground of suspecting insolvency. The reasonable person test is needed to be taken into consideration. When a director of ordinary competence who is capable of having a basic understanding of the company’s financial status would suspect insolvency. At last, the director will be held liable for the breach if he/she actually aware of the suspicion of insolvency, or any reasonable person with the same expertise, knowledge and position would acknowledge the situation when the debt has occurred.

As I mentioned above, the consequences of breaching the duty to prevent insolvent trading can be serious. ASIC may disqualify the director and make them to compensate all damages. If the contravention was due to dishonesty action of director, ASIC may seek to charge the director with criminal penalty, including prison for five years.

Nevertheless, the directors may defend themselves using the following four provisions stated in S.588H. If the director has reasonable grounds to expect the company will remain solvent; If the director has been relied on the solvency information provided by other people; If the director was absence from management due to illness or other good reasons. And if the director took all reasonable steps to prevent the company from incurring that debt. Consequently, the director may argue the preceding terms to defend themselves been prosecuted on breaching director’s duty.