What is insolvent trading?

Insolvent trading is an offence. ASIC can investigate and may prosecute offending directors.

Insolvent trading is when directors allow their company to incur debts when the company was insolvent. The liquidator can make a compensation claim against a director if those debts are unpaid when the liquidation commences. A director may be held personally liable to compensate creditors for the amount of the unpaid debts incurred from the time the company became insolvent to the start of the liquidation.

Liquidators are obliged under the provisions of the Corporations Act 2001 to investigate the existence of any insolvent trading claim, and if so, take appropriate action. Further, directors have a duty to stop a company from incurring debts it is unable to pay. Under the Corporations Act, failing to stop a company from incurring debts it is unable to pay is a breach of the directors’ duty. Directors may have to pay compensation to the company for losses creditors have incurred under that breach of duty.

Liquidators have the first opportunity to make insolvent trading claims. If they decide not to make a claim, creditors may start their own actions, but creditors’ claims are limited to the amount of their individual debt.

If a liquidator does not pursue an insolvent trading claim, the company’s creditors (individually or in a group) can make a claim. Creditors may start an action either with a liquidator’s consent or if the liquidator fails to provide their consent, the creditors can seek leave of the court in certain circumstances.

Creditors can only take action against directors for their own debts. Whereas a liquidator can pursue an insolvent trading claim on behalf of all creditors’ unpaid claims.

A creditor cannot commence action when a liquidator has already begun proceedings or has intervened in an application for a civil penalty order. That is, claims are restricted when the liquidator has started their own action.