Insolvent Trading: Can Directors Be Personally Liable for Company Debts?

When a company trades while insolvent, the directors can be held personally liable for the debts the company incurs. This isn’t a theoretical risk — liquidators actively pursue insolvent trading claims, and the financial consequences for directors can be devastating.

Section 588G of the Corporations Act 2001 (Cth) is the provision that keeps directors up at night. Here’s what it says, what it means, and what you can do to protect yourself.

What Is Insolvent Trading?

A company is insolvent if it is unable to pay all of its debts as and when they become due and payable (section 95A of the Corporations Act). This is a cash flow test — it’s not about whether the company’s assets exceed its liabilities on a balance sheet. A company can be asset-rich but insolvent if it cannot meet its debts as they fall due.

Insolvent trading occurs when a company incurs a debt at a time when the company is insolvent, or becomes insolvent by incurring that debt, and the director was aware (or should have been aware) that there were grounds for suspecting insolvency.

Section 588G: The Director’s Duty

Section 588G imposes a duty on directors to prevent insolvent trading. The provision is engaged when:

1. The person is a director of the company at the time the debt is incurred
2. The company is insolvent at that time, or becomes insolvent by incurring the debt
3. At the time the debt is incurred, there are reasonable grounds for suspecting the company is insolvent or would become insolvent
4. The director is aware that such grounds exist, or a reasonable person in a like position would be so aware

Note the two limbs of element (4): the director can be liable if they actually knew there were grounds for suspecting insolvency, or if a reasonable person in their position would have known. Ignorance is not a defence if a reasonable director would have been aware.

When Does Personal Liability Arise?

If section 588G is contravened, the director may be liable to compensate the company (or creditors through the liquidator) for the loss or damage resulting from the contravention. In practice, this means the director may need to pay, from their personal assets, the amount of the debts the company incurred while trading insolvently.

The liability can be enormous. If a company trades for months or years while insolvent, the accumulated debts can run into millions of dollars — and each director can be liable for the full amount.

Claims under section 588G are brought by the company’s liquidator under section 588M. Creditors can also bring proceedings in their own name in certain circumstances under section 588R.

Warning Signs of Insolvency

ASIC has published a list of common indicators of insolvency that directors should monitor. These include:

• Ongoing losses and poor cash flow
• Increasing difficulty paying creditors on time
• Creditors being paid outside of normal trading terms
• Inability to produce accurate and timely financial information
• Special arrangements with selected creditors
• Overdue taxes and superannuation
• Inability to raise additional finance
• Suppliers placing the company on cash-on-delivery (COD) terms
• Post-dated cheques or dishonoured payments
• Legal action threatened or commenced by creditors
• Inability to pay employees’ entitlements on time
• Directors’ loans increasing with no repayment plan

If your company is displaying any of these signs, you should obtain legal and financial advice immediately. The earlier you act, the more options you have — and the stronger your defences will be if a claim is later made.

Defences to Insolvent Trading

The Corporations Act provides several defences to an insolvent trading claim:

1. Reasonable Expectation of Solvency: Section 588G(2)

A director has a defence if, at the time the debt was incurred, the director had reasonable grounds for expecting that the company was solvent and would remain solvent even after incurring the debt. This is an objective test — the director’s subjective belief is not sufficient unless it was objectively reasonable.

To rely on this defence, you need evidence of what information you had at the time and why it was reasonable to conclude the company was solvent. This is why maintaining proper financial records and obtaining regular financial reports is so critical.

2. Reasonable Steps: Section 588G(2)

A director may also have a defence if they took reasonable steps to prevent the company from incurring the debt. Reasonable steps might include seeking professional advice, attempting to appoint an administrator, or taking other steps to prevent the company from continuing to trade.

3. Reasonable Reliance on Others: Section 588G(2)

A director may have a defence if they reasonably relied on information provided by a competent and reliable person — such as the company’s accountant or CFO — that indicated the company was solvent. However, blind reliance on management without independent inquiry is unlikely to be sufficient.

4. Illness or Other Good Reason: Section 588G(2)

A defence is available if the director, because of illness or for some other good reason, did not take part in the management of the company at the relevant time. This defence has a narrow application — it doesn’t protect directors who simply fail to pay attention.

5. Safe Harbour: Section 588GA

The safe harbour provision, introduced in 2017, provides a defence to insolvent trading where the director, after beginning to suspect insolvency, starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company than the immediate appointment of an administrator or liquidator.

To qualify for safe harbour, the director must:

• Be developing a course of action reasonably likely to lead to a better outcome
• Ensure employee entitlements are being paid
• Ensure tax reporting obligations are being met
• Obtain appropriate advice from an appropriately qualified entity

Safe harbour is a powerful defence, but it requires proactive steps. It protects directors who are genuinely trying to restructure or save the business — not directors who are simply hoping things will improve. For detailed guidance, see our page on safe harbour for directors.

How Liquidators Pursue Insolvent Trading Claims

When a company enters liquidation, the liquidator will investigate the company’s affairs, including whether it traded while insolvent. If the liquidator identifies potential insolvent trading, they will typically:

1. Investigate the company’s financial records to determine when insolvency occurred
2. Identify the debts incurred after the date of insolvency
3. Issue a letter of demand to the directors, setting out the claim and the amount sought
4. Commence proceedings if the directors do not agree to pay or negotiate a settlement

Liquidators may also seek litigation funding from third-party funders to pursue insolvent trading claims. This means that even where the liquidator has limited funds in the liquidation, claims can still be pursued against directors.

Compensation and Penalties

The consequences of an insolvent trading finding can include:

• Compensation orders — the director may be ordered to compensate the company for the amount of the debts incurred while insolvent (section 588M)
• Civil penalty orders — the court can impose civil penalties of up to $1.565 million for individuals (5,000 penalty units, in addition to compensation)
• Criminal penalties — if the director was dishonest in allowing the company to trade while insolvent, criminal penalties including imprisonment for up to 5 years apply (section 588G(3))
• Disqualification — the director may be disqualified from managing corporations

Practical Tips for Directors

Based on our experience advising directors in financial distress and defending insolvent trading claims, here are our key recommendations:

• Monitor cash flow religiously. The insolvency test is a cash flow test. If you don’t know your cash flow position, you can’t know if you’re solvent.
• Maintain accurate financial records. This is both a legal obligation and your best evidence that you were monitoring the company’s financial health.
• Get regular financial reports. Monthly management accounts, aged debtor and creditor reports, and cash flow forecasts should be standard practice.
• Act on warning signs immediately. If you see any of the indicators listed above, get professional advice. Don’t wait to see if things improve.
• Document everything. If you’re concerned about solvency, document the steps you’re taking — the advice you’re obtaining, the restructuring options you’re exploring, the information you’re relying on. This evidence is critical to the defences under s588G(2) and the safe harbour.
• Consider safe harbour early. If you suspect insolvency, engage an insolvent trading lawyer and an appropriately qualified restructuring adviser immediately. The safe harbour defence is only available while you’re actively pursuing a better outcome.
• Don’t resign and hope for the best. Resignation doesn’t necessarily protect you from liability for debts incurred before you resigned, and it removes your ability to influence the company’s direction. Get advice before making that decision.

How Boss Lawyers Can Help

Whether you’re a director concerned about your company’s solvency, a director facing an insolvent trading claim, or a creditor seeking to hold directors accountable, Boss Lawyers can assist.

Our insolvent trading team provides advice on:

• Director liability exposure assessments
• Safe harbour compliance and documentation
• Defence of insolvent trading claims
• Negotiation with liquidators
• Restructuring options to avoid insolvency

Contact us on 1300 267 711 or visit us at Level 27, Santos Place, 32 Turbot Street, Brisbane QLD 4000.

This is general information only and is not legal advice. You should obtain legal advice specific to your circumstances.