BY Marcelle Chester
Australia has some of the most severe and wide-reaching provisions prohibiting insolvent trading. It is essential that organisations are aware of the indicators and consequences of insolvent trading, and implement processes to protect the organisations and their officers from harm.
To determine whether an organisation is insolvent, an organisation’s financial position should be considered as a whole. Organisations should employ a forward-looking cash-flow test, that is, can the organisation pay all its debts as and when they become due and payable?
Insolvency is not simply determined by whether an organisation’s assets exceed its liabilities. Organisations are able to take into account their ability to sell assets or borrow money. Organisations should note the difference between a ‘temporary lack of liquidity’ (the organisation may be solvent) and ‘endemic shortage of working capital’ (the organisation is likely insolvent).
You should be wary of the following common indicators of insolvency:
If your organisation is experiencing any of the above factors you should take immediate action.
When is a company insolvent?
“A person is solvent if, and only if, the person is able to pay all the person’s debts as and when they become due and payable.” Section 95A of the Corporations Act 2001 (Cth) (the Act)
When is a debt incurred?
A debit arises when a company becomes liable to pay a liquidated sum. A debt is distinct from a right to liquidated damages and can include contingent liabilities such as guarantees. The Courts will consider each case on its own facts, therefore when a company incurs a debt will depend on its own facts and circumstances.
Directors’ duty to avoid insolvent trading
Directors of companies are bound by a duty to avoid insolvent trading under the Act, the Australian Charities and Not-for-profits Commission Act 2012 (Cth) (the ACNC Act) and the common law. Unlike other directors’ duties under the Act, the duty to avoid insolvent trading and the penalties for a breach of this duty in the Act have not been switched off for companies registered as charities.
Directors of companies can be held personally liable for insolvent trading:
It is important to note that Directors can still be found liable even if the Director has acted honestly. Further, a Director’s liability is not absolved if a company’s position improves during the insolvent trading period.
The following individuals can be found liable for insolvent trading:
In the case of a Director facing liability for insolvent trading, the following defences are available:
Directors have various duties under the Act and common law. Generally, these duties are to act in good faith, not to improperly use their position or information, act with care and due diligence and in the best interests of the company.
Directors’ primary duty is always to act in the best interests of the company, however Directors’ considerations will shift if their company is approaching insolvency. When a company is solvent, a Director’s duty will be primarily to act in the best interests of the company, although if a company is moving towards insolvency, a Director must have regard to creditors, including employees. There are few cases that have considered this in practice.
Management committee members are bound by duties under the relevant state or territory incorporated associations legislation, Standard 5 of the ACNC Governance Standards under the ACNC Act and the common law. These duties include the duty to act in good faith, not to act for an improper purpose, act with care and diligence, act in the organisation’s best interests and avoid conflicts of interests. Namely, the duty to act with care and diligence requires management committee members to inform themselves of the organisation’s financial position and avoid insolvent trading.
There has been uncertainty about the application of insolvency provisions to incorporated associations and whether management committee members could be found personally liable for debts incurred while insolvent. The Supreme Court of Queensland found in Robson & Ors v Commissioner of Taxation  QSC 76 (Robson case) that the insolvent trading provisions in the Act which allows liquidators to recover property from Directors does not apply to incorporated associations. The Robson case examined the application of the insolvent trading provisions in the Act to Queensland’s incorporated associations legislation and Justice Jackson noted in his decision that simple amendments to the Queensland legislation could reverse this position.
There is, however, scope for management committee members to be found personally liable for insolvent trading. It seems as though the legislature intended for the insolvent trading provisions in the Act to apply to incorporated associations as well as companies.
In the case of a management committee member facing liability for insolvent trading, the following defences are available: