Insolvent Trading: When Directors Become Personally Liable

In Australia, a company structure generally protects directors from personal liability. Insolvent trading is one of the key exceptions.

In this episode of Explain That by Velocity Legal, Andrew Henshaw is joined by insolvency lawyer Seamus Ryan to explain how insolvent trading operates in practice, how claims arise, and what directors should be doing when financial pressure begins to build.

What Is Insolvent Trading?

Insolvent trading arises where a director allows a company to incur debts while it is insolvent.

If that occurs, a director may be personally liable for debts incurred during that period, provided there were reasonable grounds to suspect that the company was insolvent at the time those debts were incurred.

The issue is rarely straightforward. Determining whether a company was insolvent, and identifying the relevant period, often requires detailed analysis of the company’s financial records.

How Claims Arise in Practice

In most cases, insolvent trading claims are not brought by ASIC. They are typically pursued by liquidators after a company enters liquidation.

Liquidators review the company’s books and records to determine:

• when the company became insolvent
• whether directors ought to have known or suspected this
• the value of debts incurred during that period

Where there is a viable avenue of recovery, particularly where a director has personal assets, claims are more likely to be pursued.

When Is a Company Insolvent?

Insolvency is not determined by a single factor. It is assessed by reference to a range of indicators, often requiring a detailed review of the company’s financial position rather than any one event.

These indicators may include:

• an inability to meet debts as they fall due
• cash flow pressure or missed payments
• defaulting on payment arrangements
• a net asset deficiency

Often, insolvency is identified through a combination of factors rather than a single point in time. In some cases the date is clear, while in others it is contested.

Common Misconceptions

“I Can Avoid Liability by Resigning”

Resignation may limit exposure to future debts, but it does not remove liability for debts incurred while acting as a director. Addressing the issue early is generally more effective than exiting the role.

“Good Intentions Are Enough”

Directors may genuinely believe a company can recover. However, liability turns on whether that belief was reasonable having regard to the company’s financial position at the time.

“This Only Applies to Large Companies”

Insolvent trading is not confined to large corporations. Claims can arise in small and medium-sized businesses, and the amounts involved can still be significant.

The Role of the ATO and Post-COVID Trends

The ATO is often the largest creditor in insolvency scenarios. As a result, there can be overlap between insolvent trading claims and director penalty notices, with payments in one context potentially affecting the other.

During the COVID period, enforcement activity reduced and temporary protections applied. In the period since, enforcement has increased. Some businesses that continued trading through that period without addressing underlying issues are now facing liquidation and potential claims.

Practical Steps for Directors

Directors should act early when financial pressure emerges.

Practical steps include:

• ensuring accurate and up-to-date financial records
• engaging with accountants to assess solvency
• seeking legal advice where concerns arise
• considering restructuring options, including safe harbour
• taking decisive action rather than delaying

A consistent theme is that delay increases risk. Early advice provides more options and can materially affect outcomes.

The Takeaway

Insolvent trading remains one of the few areas where directors can become personally liable for company debts.

For directors, the key issue is not only understanding the legal framework, but recognising when a business is approaching risk and responding early. The earlier the issue is addressed, the greater the range of options available and the lower the potential exposure.

🎧 Watch the full episode of Explain That by Velocity Legal for a practical discussion of insolvent trading and director risk.

For advice on insolvency, restructuring or director exposure, contact Velocity Legal’s Insolvency team. https://www.velocitylegal.com.au/insolvency