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How to avoid insolvent trading


Directors have an obligation to prevent companies from incurring debts if they are not able to pay those debts.  The Australian Securities and Investments Commission has written a regulatory guide which gives some guidance for directors about meeting that obligation.  ASIC sets out four principles, namely:

  • directors should keep themselves informed about the company’s financial position;
  • directors should continually track a company’s solvency and investigate financial difficulties;
  • directors should take professional advice to address financial difficulties; and
  • directors should consider and act in a timely way on the advice.

These principles reflect ASIC’s interpretation of section 588G(2) of the Corporations Act 2001.  Directors who follow those principles are more able to be persuade ASIC that they took reasonable steps to comply with their obligations.   The Regulatory Guide acknowledges:

  • directors should take appropriate advice  because the issue involves complex legal and accounting issues.
  • compliance depends “on all the circumstances of the company, including the size and complexity of the business as well as the skills and experience of the company’s management and staff’;
  • the test of insolvency requires analysis of cash flow, a balance sheet and other commercial factors;
  • claims made be brought against directors by ASIC, a liquidator or a creditor for determination by the Courts;
  • a Court may exonerate a director who acts honestly and ought fairly to be excused.

Read RG 217 Duty to prevent insolvent trading: Guide for directors.

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