Duty to Prevent Insolvent Trading

An updated guide for directors

Section 588G of the Corporations Act 2001 is crucial for directors to understand, as it imposes strict obligations to prevent insolvent trading. Accountants play a vital role in educating clients on these responsibilities, particularly when businesses face financial distress.

What is section 588G?

This section places a duty on company directors to avoid incurring debts if the company is insolvent or likely to become insolvent. Breaching this duty can result in serious consequences, including compensation claims, civil penalties, and potentially, criminal charges.

Key triggers and risks

1. When does it apply?
   • If the company is already insolvent or becomes insolvent by incurring a debt.
   • Directors knew, or ought to have reasonably suspected, insolvency.
2. Consequences for breach
   • In rare cases, criminal charges for reckless or dishonest breaches, potentially leading to imprisonment.
   • In some bases, civil penalties up to $200,000 for individuals.
   • Most commonly, personal liability for compensation to creditors, the claim for which is made by a Liquidator.

Defences available

Directors may avoid liability if they can demonstrate:

• They had reasonable grounds to expect the company was solvent.
• They relied on competent information or advice indicating solvency.
• They took appropriate steps to prevent the debt from being incurred.
• They did not take part in the management of the company at the relevant times due to illness or some other good reason.

Why it matters for accountants

Your clients may not fully appreciate the financial and legal risks of insolvent trading. Educating them early can prevent costly breaches. Encourage directors to:

• Regularly review financial statements and cash flow.
• Periodically review the indicators of insolvency.
• Seek professional advice if insolvency is suspected.
• Act promptly by consulting insolvency professionals where necessary.

Helpfully, ASIC has recently released an update guide for directors in this regard, which can be obtained here.

By supporting clients with timely advice, accountants can help mitigate risks, preserve businesses, and uphold directors’ legal responsibilities.