Insolvent trading in Australia: When am I liable?

Do you suspect, or have you been told, that your company may be insolvent? If so, you’re likely worried about the risk of insolvent trading and personal liability – and saying you feel stressed is no doubt an understatement.

When you’ve built a business, the fear of losing it can put you in scramble mode. You may be trying everything possible to improve cash flow and pay creditors, while wondering whether your decisions could expose you. This guide explains your risks, defences and options.

See our full guide: Are directors liable for company debts? Know your risk

What is insolvent trading?

Most directors understand that a company is insolvent when it can’t pay its debts when they fall due. This definition sits under Section 95A of the Corporations Act 2001 (Cth) (the Act). 

Insolvent trading happens when you allow your business to take on new debt when it’s insolvent or when you reasonably suspect it may be – and you’re aware of the circumstances indicating insolvency (Section 588G). 

Examples of taking on new debt

• Starting a new supplier account or purchasing goods on credit

• Entering into or renewing a lease agreement

• Accepting a new loan or finance arrangement

• Continuing to accumulate unpaid pay-as-you-go (PAYG) withholding, goods and services tax (GST) or superannuation obligations owed to the Australian Taxation Office (ATO)

• Continuing to trade while unpaid debts continue to grow

Consequences of insolvent company trading

• Personal liability and claims by a liquidator for your company debts

• Civil penalties, including fines and orders to pay compensation

• Criminal penalties – where a director was dishonest or fraudulent 

• Disqualification by the Australian Securities & Investments Commission (ASIC) from being a director 

• Damage to reputation and future business opportunities

Just to reinforce the point: you don’t need to know for sure that your company is insolvent. If you reasonably suspect insolvency, continuing to take on new debts may expose you.

Personal liability: when are you at risk?

While there are several consequences of insolvent trading, personal liability is often the biggest concern for directors. So, knowing when this risk applies is critical.

Essentially, you may face personal liability for insolvent trading where the requirements of Section 588G are met, and you fail to stop your company from taking on debts while it’s insolvent.

If insolvent trading has occurred, ASIC or a liquidator may go after you personally for debts your company took on while insolvent. This can happen even after your company has been wound up.

Liability is assessed debt-by-debt and is specific to the circumstances at the time each debt was taken on. The amount at stake can include the total value of debts – not simply a portion of those debts.

Importantly, liability isn’t limited to formally appointed directors. It can also apply to:

• De facto directors – Act in the role of director even though not officially appointed.

• Shadow directors –  Not directors but directors usually follow their instructions or wishes.

Director Penalty Notices (DPNs) are a separate but related personal liability risk for unpaid PAYG withholding and superannuation guarantee charge (SGC) liabilities. 

Learn more: Director Penalty Notices 

The longer your company continues trading while insolvent, the larger your potential director’s liability for insolvent trading, so acting early matters.

Defences against insolvent trading claims

If a liquidator or ASIC alleges you breached your duty to prevent insolvent trading, what insolvent trading defences are available to you?

Allegation isn’t automatic personal liability, and under Section 588H of the Act, you may be able to access several defences.

Statutory defences under s588H

• Reasonable grounds to expect solvency – You had reasonable grounds to expect, and did expect, your company was solvent when the debt was taken on. 

• Reliance on a competent person – You relied on information about your company’s solvency from someone you reasonably believed was competent and reliable, such as an accountant. 

• Non-participation in management – You weren’t involved in managing the company because of illness or another valid reason.

These defences can help if you’re facing an insolvent trading claim, but what if you’re trying to save your company before it gets to that point?

Safe harbour under s588GA

Introduced in 2017, safe harbour can protect directors from insolvent trading liability while they attempt to restructure their company.

To qualify, the restructuring attempt must be genuine. You must be developing or implementing a course of action reasonably likely to achieve a better outcome than immediately entering voluntary administration (VA) or creditors’ voluntary liquidation (CVL). 

You must also take appropriate steps, and immediately seek professional advice from a qualified restructuring adviser. Beware: safe harbour for insolvent trading requires prompt action – delay may remove your protection.

Read our full guide: Protecting yourself as a director

Already trading while your company is insolvent? What to do

If you’ve already been trading while insolvent, what now? The key is not to panic – but to take swift action. Immediate actions you should take include:

• Not taking on new debts – Every new debt you take on now may increase your personal liability for insolvent trading

• Seeking urgent specialist advice – Having a confidential chat with someone fluent in restructuring and insolvency will give you clarity and clear options.

At this stage you have three possible options depending on your company’s situation: 

1. Safe harbour and restructuring – If a viable restructuring plan is achievable and you’re taking steps towards it

2. Voluntary administration (VA) – If your business may be rescued through a Deed of Company Arrangement (DOCA)

3. Creditors’ voluntary liquidation (CVL) – If rescue isn’t possible and your company needs to be wrapped up smoothly

Taking one of these formal paths can help stop the clock on further insolvent trading claims. 

While rescuing the business if it’s in financial difficulties is often what directors hope for, a CVL is the most common and often most appropriate path for those who are already insolvent trading.

It might be a relief to know that company liquidation doesn’t automatically mean personal bankruptcy. Your company is a separate legal entity, so its debts don't inevitably become your personal debts. 

See our full guides:   Are directors liable for company debts? Know your risk

 Delay increases corporate insolvency liability risk

Insolvent trading liability for company directors is real and can be significant. But it’s also avoidable and, in many cases, defensible, if you act early.

Understanding your obligations, risks and options when your company is in financial distress gives you the opportunity to make informed decisions, protect yourself and explore pathways to restructure, recover your business or make an orderly exit.