Insolvent trading is one of the most common causes of director personal liability in Australia. Under section 588G of the Corporations Act 2001 (Cth), a director who allows a company to incur debts while it is insolvent — or when there are reasonable grounds to suspect insolvency — can be held personally liable for those debts. Here is what directors consistently get wrong.
What Is Insolvent Trading?
Section 588G imposes a duty on directors to prevent insolvent trading. Two elements must be established to hold a director liable:
- The company was insolvent at the time the debt was incurred, or became insolvent by incurring it; and
- The director had reasonable grounds to suspect insolvency, or would have had reasonable grounds if they had exercised due diligence.
Critically, a director does not need to have actual knowledge of insolvency. Reasonable grounds to suspect insolvency — a lower threshold than certainty — is sufficient to trigger the provision. This catches many directors who tell themselves “I didn’t know things were that bad.”
How Is Insolvency Determined?
Courts apply two tests when assessing whether a company was insolvent:
- Cash flow test: The company is unable to pay its debts as and when they fall due (s95A(1) of the Corporations Act). This is the primary test applied by Australian courts.
- Balance sheet test: The company’s liabilities exceed its assets.
Both tests are relevant, but the cash flow test dominates in practice. As the High Court confirmed in Sandell v Porter (1966) 115 CLR 666, a company is insolvent if it cannot pay debts as they fall due from its own money or money it can raise by realising assets or borrowing on reasonable commercial terms.
An important practical point: insolvency does not require a court declaration before it becomes relevant. A liquidator appointed months or years later can prove insolvency retrospectively — often by obtaining financial records, bank statements, and creditor correspondence and reconstructing the company’s financial position at critical dates. Directors who think “we were never declared insolvent” misunderstand how the law works.
The 5 Biggest Mistakes Directors Make
Mistake 1: Continuing to Trade Hoping Things Will Improve
This is by far the most common error. A director notices the company is struggling — creditors are chasing, the bank account is tight — but believes that if they can just get through the next quarter, things will turn around. Courts have consistently rejected this reasoning. The duty to prevent insolvent trading is ongoing. Each new debt incurred while the company is insolvent is a fresh potential liability. The longer a director trades on hope rather than evidence, the greater their personal exposure becomes.
Mistake 2: Relying on a Future Payment or Contract That Hasn’t Arrived
Directors frequently defend their decisions by pointing to an anticipated payment, a contract in negotiation, or an investment that was “about to come through.” Unless that payment or contract was sufficiently certain to justify a reasonable expectation of solvency, it will not assist. Courts assess what a director reasonably knew or should have known at the time each debt was incurred — not what they hoped would happen.
Mistake 3: Assuming a Bank Overdraft or Credit Facility Means the Company Is Solvent
Having an overdraft or line of credit does not make a company solvent. If the overdraft is at or near its limit, if the bank has issued notices of concern, or if the company cannot service the facility, the company may well be insolvent notwithstanding available credit. Directors who point to “available credit” as evidence of solvency often discover that argument carries little weight once a liquidator examines the true financial position.
Mistake 4: Not Keeping Proper Financial Records
Under s286 of the Corporations Act, a company must keep financial records that correctly record and explain its transactions and financial position. Failure to maintain adequate records creates a presumption of insolvency in certain circumstances (s588E). More practically, a director who cannot demonstrate what they knew about the company’s finances — because the records were not kept — has no evidentiary basis to run the defences available under s588H. Good records are a director’s primary protection.
Mistake 5: Ignoring Warning Signs and Deferring Advice
The “I didn’t know” defence is the most commonly attempted and the most frequently rejected. The test is not what the director actually knew — it is what a reasonable person in the director’s position would have known. Directors who avoid opening financial statements, ignore calls from creditors, or delay seeking legal or accounting advice do not escape liability by remaining wilfully ignorant. Courts treat deliberate ignorance as evidence against a director, not in their favour.
Warning Signs Courts Say Directors Should Recognise
Case law has identified a range of indicators that courts and liquidators treat as warning signs of insolvency. A director who ignores these does so at their peril:
- Creditors placing accounts on hold or requiring upfront payment before supply
- ATO debt accumulating; superannuation guarantee charge (SGC) overdue
- Inability to pay wages or employee entitlements on time
- Bounced cheques or dishonoured direct debits
- Suppliers placing the company on cash-on-delivery terms
- Director Penalty Notices (DPNs) issued by the ATO
- Cashflow forecasts consistently showing shortfalls
- Requests for extended payment terms from creditors becoming the norm
If several of these indicators are present simultaneously, there are almost certainly reasonable grounds to suspect insolvency. A director in that position needs urgent legal and financial advice.
The Safe Harbour Defence — Section 588GA
Introduced in 2017, the safe harbour defence under s588GA is now a critical tool for directors navigating financial difficulty. The safe harbour protects a director from personal liability for debts incurred while they are taking a course of action that is reasonably likely to lead to a better outcome for the company — and its creditors — than immediate liquidation or voluntary administration.
The safe harbour is not automatic. To rely on it, a director must:
- Be actively developing or implementing a restructure or turnaround plan;
- Be obtaining appropriate advice from a suitably qualified adviser (typically a lawyer or insolvency practitioner);
- Ensure the company is keeping employee entitlements current — wages and superannuation must be paid;
- Maintain the company’s financial records in a manner that allows the adviser to properly assess the position.
The safe harbour is available for voluntary administration, formal restructuring advice, and DOCA (Deed of Company Arrangement) negotiations. The critical point is that it must be proactively engaged before or during the period of financial difficulty — not raised for the first time after a liquidator commences proceedings. Directors who engage qualified advisers at the first sign of serious financial stress are in a far stronger position than those who wait until the company collapses.
Other Defences Under Section 588H
Even without the safe harbour, s588H provides several defences to an insolvent trading claim:
- Reasonable grounds to expect solvency: The director had reasonable grounds to expect, and did expect, that the company was solvent at the time the debt was incurred and would remain solvent after doing so. Note: genuine, evidence-based expectation — not mere hope.
- Absence due to illness or other good cause: The director was not involved in management due to illness or another cause beyond their control, and did not take part in the management decision to incur the debt.
- Reliance on a qualified adviser: The director relied in good faith on information provided by a competent, qualified person (accountant or lawyer) who had access to all relevant information and whose advice turned out to be incorrect.
Each of these defences is strictly construed. Courts examine exactly what the director knew, what advice was received, and whether reliance on that advice was reasonable in all the circumstances.
Consequences of Insolvent Trading
The consequences of an insolvent trading finding are serious and personal:
- Civil liability: Under s588M, a director can be personally liable for the amount of debts incurred while the company was insolvent. A liquidator can bring proceedings against the director directly to recover those amounts for the benefit of creditors.
- Criminal liability: Section 588G(3) provides that if the director was dishonest in allowing the company to trade while insolvent, it is a criminal offence attracting significant fines and imprisonment.
- ASIC disqualification: ASIC regularly commences disqualification proceedings against directors found to have allowed insolvent trading, with automatic disqualification periods of up to five years for repeat offenders.
One of the most common misconceptions is that resigning as a director before the company enters liquidation eliminates personal liability. It does not. Liability is assessed at the time the debts were incurred. If a director incurred debts while the company was insolvent and then resigned the day before voluntary administration, they remain exposed for those debts.
What to Do If Your Company Is Struggling
The single most important thing a director can do when a company is in financial difficulty is to act promptly:
- Seek legal and insolvency advice immediately — the safe harbour begins when formal advice is engaged;
- Stop incurring new debts you have genuine grounds to believe cannot be paid;
- Document every significant decision and the basis on which it was made;
- Consider voluntary administration — an administrator has 20 business days to assess whether a DOCA is viable and whether it offers a better outcome than liquidation;
- Engage a registered insolvency practitioner before the point of no return, not after.
Early intervention almost always produces a better outcome — for the company, for creditors, and for the directors personally.
Frequently Asked Questions About Insolvent Trading
Can I resign as a director to avoid insolvent trading liability?
Resignation does not extinguish liability for debts already incurred while the company was insolvent. Courts look at the timing of debts, not the timing of resignation. A director who resigns on the eve of administration may still face personal liability for debts incurred in the preceding months.
What happens if I didn’t know the company was insolvent?
The test is objective, not subjective. Courts ask whether a reasonable person in the director’s position would have had grounds to suspect insolvency. If the financial records showed warning signs that a reasonable director would have identified, ignorance of those signs is not a defence.
Does the safe harbour protect all directors automatically?
No. The safe harbour under s588GA must be proactively engaged. The director must take a defined course of action reasonably likely to produce a better outcome for creditors than immediate liquidation, and certain conditions must be met — including keeping employee entitlements current. Simply hoping the company will recover is not sufficient.
Can a liquidator pursue me personally for insolvent trading years after the company collapsed?
Yes. Liquidators typically have three years from the winding up date to commence proceedings, though courts can extend this period in appropriate circumstances. This means personal liability can arise long after a director has moved on from the company.
Get Advice Now — Not After the Liquidator Is Appointed
If you are a director of a company that is struggling financially, the time to get advice is now — not after a liquidator is appointed. Mark Harley has acted in Federal and state court proceedings involving insolvent trading claims, director duty breaches, and personal liability exposure. For confidential advice on your situation, contact our insolvency lawyers Brisbane or director disputes lawyers Brisbane on 1300 267 711.
This is general information only and is not legal advice. You should obtain professional advice specific to your circumstances.
