Update: Insolvent trading laws have been temporarily suspended due to the COVID-19 pandemic, as it will be difficult for many companies to avoid insolvency over the next few months. For the next 6 months, insolvency laws will change to revoke personal liability for trading whilst insolvent. This is in the hope that businesses will return to solvency once the crisis eases off and companies will be able to repay their debts. However, it’s important to bear in mind that directors will still be liable for fraud or other criminal conduct.
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Insolvent trading
Being the director of a company means that there are certain duties you have to comply with. One of these is the duty not to incur new debts whilst your company is insolvent. Directors who do this can be held personally liable. In serious cases, you can face significant fines and time in jail. Read on to find out what you need to know about insolvent trading and its consequences. Despite recent amendments which have suspended laws against insolvent trading, it’s important to understand this suspension will be lifted and trading whilst insolvent can get businesses in more financial trouble down the line.
What Is Insolvency?
As per the Corporations Act 2001 (Cth), a company is insolvent if they are unable to pay their debts while they are due and payable. If your debts exceed your profit, then you are insolvent. Therefore, your company can be insolvent even though your total assets are greater than your total liabilities. This may be the case if your company has a lot of assets that aren’t easily liquidated. Moreover, it will depend on the type of debt that your company has incurred, to determine when they are due and payable.
What Does It Mean to Perform Insolvent Trading?
Insolvent trading means trading while your company is suffering insolvency. Specifically, this refers to incurring new debt while your company is insolvent. As a director of a company, one of your main director duties is for your company not to engage in this practice. A director engages in insolvent trading if the following conditions occur:
- The person is a director while the company is insolvent.
- That when the debt is incurred the company is insolvent or would become insolvent.
- There are reasonable grounds for suspecting that the company is insolvent, or will become insolvent as a result of the debt.
If a director engages in insolvent trading then they become personally liable for the new debts that are incurred by the company. That means they are not protected by limited liability. Therefore, the director’s personal assets are used to pay the new debt obligations. This is particularly relevant if your company goes into liquidation or bankruptcy, after being insolvent.
What Are Reasonable Grounds to Suspect That the Company Is Insolvent?
Chiefly, reasonable grounds means that on the circumstances the director knew or should have known that the company was insolvent. Examples of reasonable grounds to keep in mind are as follows:
- Running at a loss repeatedly.
- A liquidity ratio of below 1.
- An inability to borrow more money from your current bank.
- Overdue state or commonwealth taxes.
Moreover, this list is not exclusive, and there may be other circumstances that means you should have known the company is insolvent. Reasonable grounds will not exist however if you have reasonable grounds to believe that the company is solvent. Furthermore, if you have taken reasonable steps to prevent your company from incurring new debt, then you will generally not have performed insolvent trading.
How Do I Protect Myself From Insolvent Trading?
The most important thing that you can do as a director is to stay informed of your company’s financial position. Furthermore, make sure you are proactive in investigating any financial discrepancies. Moreover, you should respond quickly once you begin to suspect your company is insolvent. Currently, Government assistance is available to businesses which are experiencing financial hardship due to COVID-19. If you are eligible for any of these programs, it is well worth taking advantage of to keep your business afloat.
Conclusion
Thus, make sure you know about insolvent trading to prevent yourself from becoming personally liable. Moreover, ensure you receive legal advice from an insolvency lawyer to understand your responsibilities and prevent yourself from engaging in insolvent trading.
