Home › Corporations Law › 7 · Insolvent trading
Module 7 · Insolvent trading
The duty is a statutory lifting of the corporate veil: directors are made personally answerable where they let an insolvent company keep trading. The standing composition is losses, supplier slippage and credit indicators, a board approving a debt-funded rescue, then liquidation, and the marks are in running the four-question loop once for each director.
Cases at a glance
| Case | In a line |
|---|---|
| Hawkins | Debts are voluntary, unavoidable obligations to pay certain sums |
| Southern Cross Interiors | An unenforced debt is still incurred |
| Box Valley | Uncertain sums needing calculation, such as compensation, are not debts |
| Rees | Lack of cash flow alone is not insolvency, not bare liquidity |
| International Cat Manufacturing | Practical inquiry, could the company sell assets or borrow |
| Powell | The financial position as it actually was, commercial reality |
| Plymin | The spine. Indicators weighed cumulatively, suspicion as positive apprehension, all reasonable steps, resign if prevention is impossible |
| Smith | The reasonable grounds standard is objective |
| Elliott | No per-debt, per-director proof of duty or knowledge needed |
| RCA Corp | Awareness may be inferred from the director's concrete situation |
| Friedrich | What a model director ought to know from accounts and audit |
| Metropolitan Fire Systems | Expectation means grounds for confidence, not suspicion or hope |
| Tourprint International | Actual expectation required, hope, ignorance or neglect fails |
| Statewide Tobacco Services | Management left to another. Passivity fails, the duty to monitor persists |
| Hall | Honest ATO negotiation. Solvency must be thought certain or probable, honesty supporting relief |
| Re McLellan | Expectation needs reasonable figures. Honest, profitless rescue attempts support relief |
| Williams | Actual distrust of the informant defeats reliance |
| Scholz | Attending meetings despite illness sank the defence. Stay home or resign |
| Clark | Spousal trust and confidence is not a good reason for absence |
| Aris | The liquidator is the proper plaintiff |
| Treloar | A creditor may recover its own loss |
| Carrello | Holding company awareness, watch individually liable directors |
Attack plan. Four questions, in this order, for each director. 1. Does the duty apply (s 588G(1))? 2. Check the safe harbour (s 588GA) before breach. If it applies, the breach analysis never starts. 3. Breach (s 588G(2)): failure to prevent, plus actual or constructive awareness. 4. Defences (s 588H), then consequences: civil penalty, criminal liability if dishonest, recovery, relief. Then repeat: where several directors have different states of mind, the marks are in running the loop for each of them. Finish with the holding company (ss 588V to 588X) if there is a group, and tailor the advice to the party: ASIC, the liquidator and a creditor want different remedies.
The elements of s 588G(1)
The duty applies where: s 588G(1). (a) the person is a director of the company at the time it incurs a debt; (b) the company is insolvent at that time, or becomes insolvent by incurring the debt; and (c) at that time there are reasonable grounds for suspecting that insolvency.
Director at the time
RULE. gateThe duty binds directors only but takes in the whole statutory definition. De facto and shadow directors are caught, and so are directors without executive roles (ss 9, 588G(1), (2)). The definition now sits in s 9AC, so run the characterisation through Module 4.
The company incurs a debt
RULE. checklistA debt is incurred when a voluntary, unavoidable obligation to pay a certain sum arises, including where contingent or conditional (Hawkins). An unenforced debt is still incurred (Southern Cross Interiors). A sum uncertain or needing calculation, such as compensation, is not a debt (Box Valley).
- Certain transactions are deemed debts with a deemed time of incurring (s 588G(1A)): a dividend (payment or declaration), a capital reduction (taking effect), a buy-back (agreement), redeeming redeemable preference shares, financial assistance to acquire shares in the company or its holding company (agreement), and an uncommercial transaction (entry), connecting insolvent trading to the Module 10 capital transactions.
Insolvent at that time, or by incurring the debt
Solvency: s 95A. A person is solvent if, and only if, able to pay all their debts as and when they become due and payable (s 95A(1)); a person who is not solvent is insolvent (s 95A(2)). A cash-flow test, not a balance-sheet one.
RULE. compassA lack of cash flow is not itself sufficient because the test is not only about liquidity (Rees). The inquiry is practical, could the company sell assets or borrow (International Cat Manufacturing). It is also realistic, asking what the financial position actually was at that time as a matter of commercial reality (Powell).
- Rebuttable presumptions: insolvency at any point in the 12 months before a winding up is presumed for the full 12 months (s 588E(3)), and failure to keep financial records presumes insolvency for the non-compliant period, unless minor or technical only (s 588E(4), (4A)).
Reasonable grounds for suspecting
RULE. compassThe test is objective, asking whether a reasonably competent and diligent director, performing their duties properly and capable of reaching a reasonably informed opinion, would have a positive feeling of real apprehension that the company was or would become insolvent. Real apprehension excludes mere speculation, and positive excludes mere suggestion (Plymin; Smith).
- The Plymin indicators, argued cumulatively: overdue taxes, continuing losses, poor banking relations, no access to further finance or cash flow, suppliers demanding payment on delivery, post-dated or dishonoured cheques, court proceedings, and poor financial records.
- A proprietary company cannot raise funds from the public (s 113(3)), so fresh money is much harder to find. This sharpens both insolvency and suspicion.
Contravention: s 588G(2)
RULE. checklistA director contravenes where they fail to prevent the company incurring the debt and one awareness limb is met. Either the director is aware there are reasonable grounds for suspecting insolvency, or a reasonable person in a like position in a company in the company's circumstances would be so aware (s 588G(2)(a); s 588G(2)(b)).
- Failure to prevent. All reasonable steps, executive or non-executive, and where prevention is impossible, the obligation is to resign (Plymin). No proof is needed that a particular director owed a particular duty on a particular debt, and knowledge of particular debts is not required (Elliott).
- Limb (a) is subjective with foresight. The director's own state of mind, with reasonable inferences drawn from their concrete situation (Plymin; RCA Corp).
- Limb (b) is objective with foresight. Where a model director with no special expertise ought to have known, from the accounts and the audit, that suffices (Friedrich). Special expertise and an executive role raise the bar above the assumed baseline of ordinary skill, so lean into each director's position.
RULE. checklistCriminal liability attaches where the company was insolvent when the director let the debt be incurred, the director actually suspected the insolvency, and the failure to prevent was dishonest (s 588G(3)).
Safe harbour: s 588GA
Safe harbour: s 588GA(1). The duty is not contravened where (a) after starting to suspect insolvency, the director starts developing a course of action reasonably likely to lead to a better outcome for the company (not necessarily guaranteed), and (b) the debt is incurred in connection with that course of action, during the period from the start of development to the earliest of a reasonable period after a failure to take the course of action, the course of action ceasing, it ceasing to be reasonably likely to lead to a better outcome, or the appointment of an administrator or liquidator. Better outcome means better than an immediate administration or liquidation (s 588GA(7)).
- Factors on whether the course is reasonably likely to lead to a better outcome (s 588GA(2)): properly informing themselves of the financial position, steps to prevent misconduct affecting solvency, keeping appropriate financial records, advice from appropriately qualified, sufficiently informed entities, and developing or implementing restructuring plans.
- On the 2024 facts, Gemma's plan rested on her own asserted valuation. No advice, doubted figures and concealed information all cut against "reasonably likely".
RULE. The director bears an evidentiary onus to prove the course of action. The onus then shifts to the liquidator or creditor to disprove it (s 588GA(3)).
- Safe harbour is barred (ss 588GA(4), 588GB(1)) where employee entitlements are unpaid or tax lodgements not made, if less than substantial compliance, or one of two or more failures in the prior 12 months, and, as to admissibility, where books and records are withheld from the liquidator after a failed restructure.
- A temporary safe harbour covered ordinary-course debts from 25 March to 31 December 2020, with the onus on the director (s 588GAAA).
Defences: s 588H
All defences speak to the time the debt was incurred (s 588H(1)).
Reasonable grounds to expect solvency: s 588H(2)
RULE. checklistThe director must have had reasonable grounds to expect solvency continuing and must actually have expected it. Expectation means grounds for confidence rather than mere suspicion, hope or possibility (Metropolitan Fire Systems). Suspicion, hope, ignorance, neglect or a failure to make necessary inquiries is insufficient (Tourprint International). The expectation cannot be passive (Statewide Tobacco Services) and must be proactive, so that with the relevant facts in hand solvency is thought certain or probable (Hall), on reasonable figures (Re McLellan).
Reliance on another: s 588H(3)
RULE. checklistThe director must have relied on information from a person they had reasonable grounds to believe was responsible for providing adequate solvency information and was competent and reliable in that role, and the information must have supported an expectation of solvency. An accountant not specifically engaged for solvency advice is insufficient (Re McLellan). Actual distrust may be fatal (Williams).
Absence from management: s 588H(4)
RULE. checklistThe director must not have taken part in management at the time because of illness or some other good reason. Attending meetings despite illness is fatal, so stay home or resign, and give details of the condition and treatment (Scholz). Spousal trust and confidence is not a good reason (Clark), and nor is simply not attending and leaving matters to another (Statewide Tobacco Services). Good reasons include being an alternate director while the principals are present, being conflicted out, or going overseas having sought a replacement. There is an underlying obligation to participate in management, to make necessary inquiries, to take a diligent and intelligent interest in the available information and to monitor financial performance (Clark; Statewide Tobacco Services).
Reasonable steps to prevent: s 588H(5)
RULE. compassThe director must have taken all reasonable steps to prevent the debt. Swift appointment of a voluntary administrator is the paradigm, and the court weighs action taken with a view to an administration or restructuring, its timing and its results (s 588H(6)). If the director cannot prevent the debt, the options are winding up or resignation (Plymin).
Safe harbour vs the s 588H defences
| Safe harbour s 588GA | Defences s 588H | |
|---|---|---|
| Requires | a course of action, begun after suspecting insolvency, reasonably likely to lead to a better outcome than immediate administration or liquidation, with the debt incurred in connection with it | an expectation (not suspicion) of solvency, grounded reliance on a competent, reliable, responsible informant, absence for illness or good reason, or all reasonable steps to prevent |
| Operates as | a carve-out: s 588G(2) never applies, so analyse before breach | a defence excusing an established contravention |
| Who proves | the director, to an evidentiary standard, and the onus then shifts to the liquidator or creditor to disprove (s 588GA(3)) | the director |
| Fails where | employee entitlements are unpaid or tax lodgements not made (s 588GA(4)), the course ceases, fails or stops being reasonably likely, or an administrator or liquidator is appointed | numerous insolvency indicators, an informant not responsible for solvency or distrusted, attendance despite illness, or steps too little or too late |
| Exam figure | the director with a rescue plan | the dissenter, the reliant, the absent, the resigner |
Recovery and relief
RULE. On a civil penalty application the court may order the director to compensate the company where the debt is at least partly unsecured and the creditor suffered loss because of the insolvency (s 588J(1)), the liquidator intervening only on compensation (s 588J(2) to (3)). A parallel order follows criminal conviction (s 588K(1)).
RULE. The liquidator is the proper plaintiff (Aris) and recovers the loss as a debt due to the company even without any penalty order or conviction (s 588M(1) to (2)). A creditor may recover its own loss (s 588M(3); Treloar), but suit needs the liquidator's written consent or court leave (ss 588R, 588S, 588T) and is barred once the liquidator has sued or intervened (s 588U).
- Six years from the beginning of the winding up (s 588M(4)), and no double recovery (s 588N). Recoveries go to unsecured before secured debts, and a creditor who knew of the insolvency when its debt was incurred may be subordinated (s 588Y(1) to (2)).
RULE. The court may relieve a director who acted honestly and ought fairly to be excused (ss 1317S(2) to (3), 1318(1)). Honesty includes genuinely negotiating with the ATO for the period it was reasonable to think it would work (Hall). Fair excuse includes acting honestly, without profiting, while trying to fix the business (Re McLellan). Appointing an administrator counts in the director's favour.
Holding company liability: ss 588V to 588X
RULE. checklistA holding company contravenes where its subsidiary incurs a debt while insolvent, there are reasonable grounds for suspecting the insolvency, and the holding company or one or more of its directors is aware of those grounds or reasonably would be, given the nature and extent of the holding company's control (s 588V(1), reaching foreign holding companies, s 5(4)). Establish the holding and subsidiary relationship first (ss 46, 50). Watch any individual director who might be liable (Carrello).
- The subsidiary's liquidator recovers the creditor's loss from the holding company as a debt due to the subsidiary (s 588W(1)). Where the companies share directors, run s 588W alongside their own s 588M liability.
- Defences mirror s 588H, held by the holding company and each relevant, actually aware, director (s 588X): expectation of solvency, reliance, absence for good reason where the director's knowledge mattered to managing the holding company, and reasonable steps. The safe harbour is re-enacted, with reasonable steps directed to each director of the subsidiary (s 588WA).
Critical pitfalls and counter-arguments
Trap. Officers are not bound. A person who is an officer but not a director cannot contravene s 588G. Conversely, the recurring pattern (2018 Bikkies, 2022 Logan) plants an unappointed patriarch or controlling shareholder precisely so a de facto or shadow finding brings them inside the duty.
Trap. The 2024 indicators came with softeners: weigh, don't tick. Q1 stacked classic indicia ("lost money over each of the last three years", suppliers "not been paid for almost six months", the bank "unwilling to lend HSFL any more money") against softening facts, a mortgage-secured bank willing to defer, suppliers being "quite understanding", before HSFL "enters into a contract to buy the Carnegie building for $10 million". Insolvency at the moment of the new debt was arguable, not obvious, and the marks were in genuine weighing on the Plymin indicia.
Trap. The 2024 per-director pattern. Q1 gave three directors three epistemic positions on one decision: Gemma the proposer ("Gemma asserts that the building can be sold for $12 million"), Cori the dissenter ("with Cori voting against the proposal"), and Alma the silent knower ("Alma does not tell the other directors that she doubts Gemma's estimate of the value of the Richmond building"). Safe harbour, breach and defences must each be run per director with different outcomes. A single global conclusion misses the design of the question.
Trap. Expect is a higher standard than suspect. The duty triggers on reasonable grounds to SUSPECT (s 588G(1)(c)): a positive apprehension, but a low bar. The defence demands reasonable grounds to EXPECT solvency: confidence that solvency is certain or probable. A director can easily have grounds to suspect insolvency while lacking grounds to expect solvency. Writing the two words interchangeably collapses the scheme, and where numerous indicators point to insolvency the defence will rarely succeed.
Trap. Read the exclusion list surgically. 2024 Q1: "ASIC does NOT want your advice on sections 180, 181(1)(b), 182, 183, 184, 191 or 195", leaving exactly s 588G and s 181(1)(a) live, the exclusion splitting s 181 at the paragraph level. In the insolvency zone the good-faith duty picks up creditor interests, so the two live routes work together. Time spent on the excluded s 180 was time the examiners had deliberately freed.
Exam calibration. The standing composition: losses, supplier slippage and credit indicators, a board approving a debt-funded rescue, then liquidation, paired with a Module 4 characterisation twist and, in 2024, s 181(1)(a) creditor interests. Budget for the per-director loop: elements once, then safe harbour, breach and defences for each director separately.
Take it to the practice bank
This module is drilled in the Corporations Law practice bank. Every problem there carries a realistic Pass answer, an H1 model answer, and an examiner's comment explaining the decisive fact and where the marks are lost.
Practice prompts
- Take the 2024 composition, losses, patient suppliers, a reluctant bank, then a $10 million purchase, and write the insolvency paragraph that weighs the Plymin indicators both ways before concluding.
- Write the two standards side by side: the sentence finding reasonable grounds to suspect insolvency, then the sentence explaining why the same director lacks reasonable grounds to expect solvency.
- Run the four-question loop, duty, safe harbour, breach, defences, for three directors with different states of mind, and reach a different conclusion for at least one of them.
- Draft a safe harbour analysis for a director with a rescue plan, testing the s 588GA(2) factors against a plan that rests on the director's own valuation.
- Advise a liquidator and a single creditor on recovery under s 588M, covering standing, consent or leave, the six-year limit and subordination under s 588Y.
Check your understanding
Auto-marked drills. Answer, then see the authority in the feedback.