How can directors defend an insolvent trading claim?

Section 588G of the Corporations Act sets out the director’s duty to prevent insolvent trading and sets the parameters by which a liquidator can initiate the process for making a claim against a director.

Directors contravene this section by allowing the company to incur a debt when they are aware of grounds to suspect the company was insolvent.

When directors breach their duty, the provisions of section 588M of the Corporations Act allow compensation to be recovered from that director. A claim is possible where the creditors suffered loss or damage because of the company’s insolvency and the debt was wholly or partly unsecured.

The Corporations Act provides statutory defences for directors. The burden of proving these defences is on directors. The statutory defences can be summarised as:

  1. the director had reasonable grounds to expect (not just suspect) the company was solvent
  2. a reasonable, competent person produced information that would reasonably lead to a belief that the company was solvent
  3. the director had a good reason for not taking part in the company management at the relevant time
  4. the director took all reasonable steps to stop the company incurring the debt, including attempting to appoint a voluntary administrator to the company.

The courts have made it clear that the position of director carries certain responsibilities, which cannot be avoided, including the duty to keep informed about the company’s solvency.

Liquidators have six years from the beginning of the liquidation to commence an action for insolvent trading. Proceedings must be commenced by way of the filing of an application with the court within that six-year period. It is not sufficient to just issue a letter of demand. 

If a liquidator makes an insolvent trading claim, a liquidator should be asked to demonstrate:

  1. that the company was insolvent during the appropriate period
  2. that the debts were incurred after that time
  3. proof of director status at that time, whether formally appointed or not.

In settling claims with the liquidator, the settlement must be sanctioned by the court, usually by way of a consent order. This consent order protects directors from any future claims made by creditors of the company.