Insolvent trading occurs where a director incurs company debts while the company is insolvent. A director can be held personally liable for these debts if they remain unpaid when the liquidation commences.
Why do liquidations make insolvent trading claims?
A liquidator has a statutory obligation under the Corporations Act 2001 to investigate a claim of insolvent trading and to take action where appropriate. Directors also have a statutory obligation under the Act to stop a company from incurring debts that it cannot meet.
Who can make an insolvent trading claim?
Legally insolvent claims are initiated by liquidators but where a claim is not pursued a creditor may start their own action limited to their individual debt. Whereas a creditor can only pursue an action against a director for their own debt, a liquidator can seek to claim on behalf of all unpaid creditors.
A creditor can start an uncommercial transactions action either with the consent of the liquidator or with leave of the court. Where a liquidator has commenced an action there will be restrictions imposed on further abilities to claim.
Elements of the uncommercial transactions claim
The elements of an insolvent trading claim are:
- The company must be in liquidation
- At the time the debts incurred the company must have been insolvent
- At the time of liquidation the debts must remain unpaid
- The claims must be made against persons who were directors when the debts incurred
- Reasonable grounds where present for the director to suspect insolvency of the company.
It is not necessary that a person be formally appointed as a director to conclude that they were in fact a director at the time of debt. As long as a person acts as a company director, even though it is not their formal position, this element will be satisfied.
A ‘director’ is defined by the Corporations Act to be a person who is appointed as director, or is appointed as an alternate director and is acting in that capacity regardless of their actual position.
When does insolvency arise?
Section 95A of the Corporations Act provides that a company is insolvent when it cannot pay its debts when they become due and payable.
Are accrued debts sufficient?
A debt incurs at the time that it comes into existence, usually by contractual agreement. Conversely, an accrued debt usually relates to an ongoing contractual agreement to which the incurred date will be the date that the contractual agreement was made. Therefore, for an insolvent trading claim a debt must be incurred and not merely accrued while the company is insolvent.
For example, where a lease agreement is entered prior to insolvency and a payment is made following insolvency. In this case the lease agreement incurred at the time that the contract was entered and the payment only accrues when it becomes due.
A director has a duty to prevent insolvent trading pursuant to s 588G of the Corporations Act, breach of which amounts to an offence. This section is contravened where despite the presence of reasonable grounds for suspecting insolvency a director allows the company to incur debt. Where this occurs the debt can be personally recovered from a director under s 588M.
To pursue a claim the debt must be wholly or partly unsecured, and a creditor must be burdened with loss or damage as a result of the company’s insolvency.
Directors have statutory defences available under the Corporations Act, which they have the onus of proving. The defences are;
- There were reasonable grounds to expect, not merely suspect, that the company was solvent
- Information was produced by a reasonable and competent person that reasonably lead to the belief that the company was solvent
- There was good reason on the part of the director to disengage in the management of the company at the time
- All reasonable steps were taken by the director to stop the company incurring debt, including attempting to appoint a company voluntary arrangement administrator.
A liquidator must bring an action within 6 years from the start date of the liquidation. An action is commenced by filing an application with the court.
Proceeding as a director
If an insolvent trading claim is made against a director they should ask the liquidator to demonstrate;
- The company was insolvent at the time
- The debts where incurred while the company was insolvent
- Proof of directorship at the time in question.